Where are prices going next? Who knows? Bearish talk about bubbles bursting and bullish talk about peak oil disguise the fact that the future direction of oil prices is unknown and unknowable. Neither investors nor politicians ought to be betting the economic house on any particular vision of “our energy future.”
The fundamental reason for the difficulty associated with forecasting future oil prices is the fact that both demand and supply are relatively inelastic over the short term. That means rather small changes in either can have very large price effects. Hence, those who wish to forecast oil prices are forced to forecast weather patterns, labor relations, gross domestic product (GDP) reports, demographic trends, civil unrest and technological change in all sorts of disparate economic sectors.
Long‐run forecasts are no easier to execute. Professor Vaclav Smil of the University of Manitoba has cataloged the vast record of energy forecasts offered by academics, corporations, consultants, trade associations, government agencies, “blue ribbon” commissions, policy activists and “futurists” of all stripes over the past 100 years and finds a “a manifest record of failure.” There is simply no reason to believe that mere mortals can foretell oil prices or petroleum market shares in the future, absent some sort of time machine.
A recent analysis of world crude oil prices by Professor James Hamilton of the University of California at San Diego reinforces Smil’s point. In a paper published by the University of California Energy Institute, Hamilton looked at data from the first quarter of 1970 through the first quarter of 2008 and asked the question, “How predictable statistically is the change in the real price of oil over this period?” It turns out that:
- Neither nominal U.S. interest rates nor real U.S. GDP growth rates can predict oil price movements.
- Although prices increased by 172% (logarithmically) over the sample period (an average of 1.12% per quarter), Hamilton could not reject the null hypothesis that there was no trend in the data.
- The data is most consistent with the observation that oil prices move akin to “a random walk without drift.”
- The best predictor of future oil prices is the present oil price.